Mortgage-Bond Spreads Cap Biggest Weekly Drop Since December ’08

Sept. 21 (Bloomberg) -- A measure of relative yields on
mortgage securities that guide U.S. home-loan rates capped its
biggest weekly drop in almost four years on speculation that the
Federal Reserve will find a shortage of the bonds as it expands
purchases.

A Bloomberg index of yields on Fannie Mae-guaranteed
mortgage bonds trading closest to face value fell about 7 basis
points, or 0.07 percentage point, today to a record low 61 basis
points higher than an average of five- and 10-year Treasury
rates as of 5 p.m. in New York.

This week’s drop of 34 basis points, the largest since
December 2008, exceeds the decline of 19 in the final two days
of last week after the Fed’s Sept. 13 announcement that it would
expand its balance sheet with monthly purchases of $40 billion
of government-backed housing debt until the economic recovery
strengthens.

“It’s been a truly extraordinary seven days,” said Scott
Simon, the mortgage head at Newport Beach, California-based
Pacific Investment Management Co., manager of the world’s
largest bond fund. The $273 billion Pimco Total Return Fund has
used outsized bets on home-loan securities to beat 97 percent of
its peers this year, gaining 8.8 percent, according to data
compiled by Bloomberg.

Bond-Buying

The Fed’s mortgage-bond buying will probably total between
$65 billion to $75 billion a month, including a previous program
of reinvesting proceeds from repayments on its past purchases,
Nomura Securities International analysts said in a report today.
That compares with about $96 billion of issuance a month of
securities that aren’t set aside by lenders to be sold for
higher prices because they can offer more protection against
homeowner refinancing, the analysts said.

The securities that the central bank will probably focus on
“had a great run over the past two weeks,” outperforming
baskets of Treasuries with similar durations by between 1.5
cents and 2 cents on the dollar, Nomura analysts led by Ohmsatya
Ravi wrote in the report.

Home buyers and owners looking to refinance aren’t
receiving benefits from the Fed’s action equal to the size of
its effect in financial markets, as banks overwhelmed by a jump
in applications earlier this year limit how much they reduce
borrowing costs to avoid more demand.

Mortgage Rates

The average rate for a 30-year fixed mortgage fell to 3.49
percent in the week ended yesterday, matching the record low set
during the week of July 26, according to Freddie Mac. Absolute
yields on the so-called current coupon Fannie Mae mortgage
securities have fallen to 1.82 percent, from a low of 2.19
percent during that week of July.

The New York-based Nomura analysts said that the debt’s
spreads may widen in the short-term amid sales as investors book
gains from profitable trades. A long-term risk is that the Fed
may change the assets bought under its so-called quantitative
easing program, they said.

“As MBS spreads continue to tighten, there will be a point
at which the Fed might deem distortions in the MBS market to be
unacceptable and use other asset classes,” specifically
Treasuries, they wrote.

In a sign that the Fed’s buying may be straining the
market, during the week ended Sept. 19 the central bank entered
into contracts to sell $1.4 billion of mortgage-backed
securities in October, essentially canceling and pushing out
previous purchases, according to data released yesterday. The
central bank’s net purchase contracts totaled $17.5 billion
during the week.